With the approaching U.S. presidential and congressional elections in November, the debate over tax policy is sure to remain heated--specifically the fate of the Tax Cuts and Jobs Act signed into law by then-President Donald Trump in December 2017. While more than $3.4 trillion in individual income and estate tax cuts that are set to expire at the end of next year have garnered much of the attention, there's also been significant debate around certain TCJA provisions for corporations (table 1).

Table 1

Irrespective Of Election Results, TCJA Corporate Tax Deductions Are Key For 2025

The fate of some of the TCJA's corporate tax deductions--such as interest deductibility--will be a key topic in 2025, irrespective of the outcome of the elections this November. There has already been a legislative proposal to permanently extend the current tax treatment, which had passed the Republican-controlled House of Representatives but failed to pass the Senate. Whether these deductions would be extended retroactively (if at all) from their expiration dates remains uncertain. If left untouched, for tax years that began after Dec. 31, 2021, the calculation of adjustable taxable income will be based on EBIT rather than the previous EBITDA calculation, which decreases the amount of interest deductible and raises the tax liability.

Another provision that went into effect in 2022 and is attracting legislative proposals is the tax deduction for R&D expenditure over a five-year period (starting 2022) rather than fully deductible in the year incurred. Additionally, 100% deduction of tax depreciation, also referred to as bonus depreciation, which gave companies the full benefit of tax depreciation expense for the year, began phasing out in 2023.

From a corporate standpoint, the extension of the above tax deductions beyond 2025, particularly if done retroactively, will be a benefit to net income and boost post-tax cash flow, generally speaking. The 100% bonus depreciation could boost capital expenditure to the degree there are corresponding decreases in taxes payable or cash taxes paid. Moreover, changes in deductibility of interest expense and R&D expense would lead to lower outflow for taxes, thereby increasing funds from operations (FFO). Lower cash outflow will also boost the cash available to service debt, all else equal.

Potential Changes To The Corporate Tax Rate

The TCJA lowered the corporate tax rate to 21% from 35% effective 2018, and did so permanently--as opposed to other elements of TCJA noted above, which phase out by 2025.

Leaders from both parties seem eager to reopen the debate on corporate tax rates. Republican leaders are already discussing passing tax reform using reconciliation, which would allow them to enact changes to the corporate tax rate without a single Democratic vote, if there is a "red wave" in November. As an example: There has been a mention about a 15% corporate tax rate for U.S. companies with only domestic production.

Key Democrats are also looking at corporate taxes as a way to lower the budget deficit and have said they would try to raise the federal rate to 28%, but this would seem to require Democratic control of Congress and the presidency. Even some Republicans have mentioned raising the corporate tax rate due to concerns about the deficit.

While it's too early to determine effective dates, a change in the corporate tax rate won't likely be effective until 2026, unless the rate change is retroactively applied. Naturally, a higher corporate tax rate would add to a company's tax expense, weigh on net earnings, and have a one-time effect on deferred tax assets or liabilities, depending on the company's net tax position. The effects on credit ratios would appear most directly from changes to FFO and, thus, to FFO-to-debt ratios and FFO-to-interest coverage. Tax rate changes may also affect our adjusted debt through a higher corporate tax rate on tax-affected liabilities (e.g., pensions).

The Corporate Alternative Minimum Tax Has Limited Reach

The Democratic proposal to increase the corporate alternative minimum tax (CAMT) to 21% from 15% is intended to address the fact that some large U.S. corporations pay little or no U.S. tax despite increasing profits. The CAMT went into effect in 2023 and applies to about 100-150 companies that reported net book income of $1 billion or more over the past three consecutive years, and have a CAMT that exceeds their tax liability. However, there are some ways companies can reduce the bite of the CAMT. For example, companies may be eligible for credit for taxes paid above the CAMT minimum book tax threshold in prior years for general business tax credits (including R&D, clean energy, and housing tax credits) and foreign tax credits.

To provide a rough estimate of the impact of a higher CAMT, we compared the current 15% minimum tax to the potential 21% minimum tax and reported 2023 current federal taxes (as a proxy for actual U.S. taxes paid; table 2) for companies that had net incomes of $1 billion or more in the past three years. Our calculations don't reflect any credit for prior period taxes paid or tax credits, which are harder to estimate. Thirteen of the 20 companies with the highest minimum tax were in the technology, consumer products, and oil and gas sectors.

Table 2

Share Buyback Tax Raises Revenue But Doesn't Deter Companies

The share buyback tax is an excise tax directly affecting EBITDA similar to excise duty paid in certain sectors--not an income tax. Its intention is to change corporate behavior and only affects a company's profitability and not the income taxes companies pay.

The 1% tax on all share buybacks effective since 2023 hasn't deterred corporations based on our review of share buybacks in 2022 and 2023 (table 3). The Democratic proposal to increase this tax to 4% will have a moderate negative impact on companies' EBITDA but is unlikely to be a hurdle for share buybacks, in our view. In our study, we recalculated the 4% impact on the top 15 companies with share buybacks compared to the current 1%. We noted that it did move the needle for certain companies if the 2023 level of buybacks continue.

Table 3

International Tax Proposals And Overhang Of OECD Global Minimum Tax

The Global Intangible Low-Taxed Income (GILTI) and foreign-derived intangible income (FDII) provisions in the TCJA disincentivize keeping intellectual property (IP) overseas. GILTI added another layer of tax on foreign earnings. Under the FDII rules, U.S. companies bringing back their IP to the U.S. benefit from a lower tax rate on that income of 13.125%. This has generally led to technology companies bringing their IP back to the U.S.

Given the complexity of the calculations and provisions, the exact effects of the proposal to eliminate FDII and the Base Erosion and Anti-Abuse Tax (BEAT; a minimum tax designed to prevent U.S.-based companies from avoiding domestic taxes by shifting profits outside the U.S.) and increase GILTI to 21% from 10.5% are difficult to determine. The sectors likely to be hurt by higher international taxes are technology and health care--particularly, those companies that have a larger share of foreign earnings compared with those that largely have domestic earnings.

A look at the effective tax rate reconciliations reported by the companies listed in table 4 gives additional insight as to how foreign earnings drive effective tax rates for many of them, primarily through FDII deductions and GILTI tax. For example, Qualcomm Inc.'s and Netflix Inc.'s 2023 rates dropped 15.7% and 6.9%, respectively, due to the FDII tax benefit. KLA Corp. and Thermo Fisher Scientific Inc. also disclosed a 3.4% and 1.8% increase resulting from the GILTI tax.

Table 4

The Organisation for Economic Cooperation and Development (OECD) had previously issued its model for a 15% global minimum tax (known as Pillar Two), with the support of the Biden administration and with more than 130 countries agreeing to implement it. Some countries have enacted the rules as of Jan. 1, 2024, while others expect to enact the rules in 2025. The U.S. has not yet enacted the OECD agreement, and instead enacted its own minimum tax rules--FDII, GILTI, and BEAT. The outcome of the U.S. elections will indicate whether the U.S. will adopt a minimum tax consistent with the OECD.

If the U.S. doesn't ultimately align with the global agreement, or otherwise change its international taxation rules, some multinational income could be subject to double taxation. As a result, multinational companies with global revenues exceeding €750 million (approximately $800 million) may begin to face higher tax rates on their international income, with some consequences beginning this year and others beginning in 2025 and later years. The timing and impact will depend on the countries the multinational companies do business in, and the country mix of their international earnings. Higher tax payment outflow would reduce FFO and weigh on cash available to service debt, all else equal.

It's All About Tax Planning And Managing Effective Tax Rates

Most companies plan for changes to tax provisions well before their effective dates, and manage their taxes and cash flow. A company-specific factor that drives effective tax rates is whether the company or sector is largely dependent on the corporate statutory rate itself or benefits from certain tax deductions/provisions. For example, companies with foreign earnings assessed the impact of international tax provisions and moved intellectual property prior to the TCJA effective date. A review of approximately 1,100 public U.S. nonfinancial corporates we rate indicated the average pre-TCJA effective tax rate was 24%. The rate fell to 13% in 2020 and was roughly 15% in 2023.

Company data on rate reconciliations for 2023 and the effective tax rates show that roughly 12% of the public companies we rate (or about 135 of 1,124 companies) relied on international tax provisions to a greater degree than the statutory rate itself. The remaining 88% of companies either rely on other tax provisions such as interest deductibility, R&D, and bonus depreciation or the corporate tax rate itself.

Borrowers we rate in the technology and health care sectors, which generally already enjoyed effective tax rates significantly lower than the pre-TCJA statutory rate, are among those continuing to report rates significantly less than the current 21% rate (chart 1). Other sectors--such as chemicals, mining and minerals, and utilities, which aren't as affected by international tax provisions--still benefited from the TCJA because of lower corporate tax rate other tax deductions.

Chart 1

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